How the Big Picture Affects Stock Picks

For fund managers, the lesson of recent years is that they can't ignore the macro impact

By

Suzanne McGee

May 7, 2012

Mutual-fund managers have little choice but to think big these days.

Most managers would describe themselves as stock pickers, insisting their main focus is evaluating companies on their merits, not making investment decisions based on broad trends such as the outlook for economic growth in China or the resolution of the European debt crisis.

But the events of the past few years have made clear how important macro considerations can be to mutual-fund managers trying to outperform a benchmark. In any given week, stock prices as a whole can soar on news that the unemployment rate has fallen, only to slump a day or two later on renewed fears that Spain will require a bailout from the European Central Bank.

In such trading—characteristic of the past year or two—investors tend not to pay much attention to what makes Company A different from Company B. What matters more is that they are stocks—and in times of recent stress, investors have tended to flee stocks en masse for safer havens like gold or Treasurys without pausing long enough to winnow out prospective winners from likely losers.

They are all evaluating the big-picture trends—"it's just a question of whether and to what extent they admit to doing it," says Bernie Williams, vice president at USAA Investments, referring to the managers who run or sub-advise the mutual funds the San Antonio-based firm offers to investors. "For whatever reason, stock selection is deemed to be more valuable and on a continuing basis more indicative of a manager's skill than getting the decision on a sector or even an asset class correct," he says.

ENLARGE

The trick, Mr. Williams and others say, is to strike a balance between understanding when macro factors are important, and when they become an unhelpful distraction. For instance, investors in mining companies need to be aware of global pricing trends and demand for metals like copper from important consumers such as China. On the other hand, they don't want to react reflexively to every bit of news about the global economy or Chinese growth forecasts.

Shifting His Approach

That is Keith Trauner's concern. As co-manager of GoodHaven Fund, Mr. Trauner says he doesn't want to be tracking every iota of economic news that might affect the stocks he owns. Even if he can anticipate what trends are taking shape—tough for even a professional economist to accomplish—he says that would leave him little time to do the kind of in-depth analysis required to identify companies that he believes have business advantages that aren't yet reflected in their share prices.

Nevertheless, in recent years Mr. Trauner has shifted his investment approach to include more macro considerations. One in particular—today's ultralow interest rates and the likelihood of higher rates in the future—has assumed a particularly important role in his stock selection. When he identifies a company he believes has enticing business prospects, he will be sure to check how any debt is structured, and think twice before buying the stock if the company's operations are financed with floating-rate debt.

Mr. Trauner also believes that significant macro-driven moves in the market can create opportunities. For instance, a few months ago he began adding housing-related stocks that had been under stress for a while to his portfolio. But he didn't draw a macro conclusion that housing was poised for a turnaround and then go in search of stocks to fit that top-down theme. Rather he identified stocks that he believed were priced at a discount, like Quanex Building Products Corp.NX0.10%, a maker of window systems with a great balance sheet and lots of cash. Then he did the macro research to understand the nature of the risks confronting companies such as Quanex.

Taking that step gave him the confidence that his bottom-up research was accurate, and he began buying Quanex at $11 a share. Recently it was trading at around $18 a share.

Tailwinds and Headwinds

To investors like Mr. Williams, doing an industry-specific macro analysis is just part of fundamental research, and he wants the managers he hires to share that perspective. "You certainly want to own a company that you believe is operating well, but you need to be aware whether that growth is being supported by some kind of tailwind," or threatened by a headwind, Mr. Williams says.

The events of 2008 certainly remind portfolio managers why that might be so. In the months leading up to the financial crisis, says Josh Charlson, senior mutual-fund analyst at Morningstar Inc., many value managers identified financial stocks as great values based on their fundamentals. Even when they picked the survivors and the eventual winners, those managers posted big short-term losses when the crisis hit. "They were so focused on the [stock-specific] fundamentals that they missed the bigger picture," Mr. Charlson says.

If one part of the macro/micro balancing act is understanding that macro information is part of the analytical picture, not something a manager should use to immediately buy or sell stock, another element is being able to identify which stocks are almost immune from macro themes. For instance, Mr. Williams believes that a company like Apple Inc.AAPL-0.87% may continue to do better than rivals, regardless of the economic landscape, because of its geographic reach and the nature of its products. Mr. Trauner, meanwhile, points out that Coca-Cola Co.KO1.28% has been "a cash machine" for investors throughout the 20th century and into the 21st century, despite a macro backdrop that included two world wars, one Cold War, a Great Depression and several social revolutions.

Reassuring Investors

But money managers need to think laterally before concluding that a stock is immune from a certain macro theme, says Mr. Williams. For example, Joy Global Inc.,JOY0.34% a provider of heavy-duty mining equipment with major customers in Australia, at first glance would appear to have no direct exposure to what happens in China. But who buys Australia's raw materials, including the metals extracted with Joy Global's machines? "If Chinese growth slumps, the company's backlog can disappear," says Mr. Williams.

While many stock pickers continue to insist that keeping the focus on individual companies is what will pay off over time, more of them appear willing to discuss the macro backdrop in their quarterly letters to investors, or to let it be known that they are using macro analyses to try to spot any signs of danger that might add to the risks one of their companies is facing, says Mr. Charlson.

At the very least, he says, it is becoming clear even to die-hard stock pickers that it is important to show that they aren't so focused on analyzing balance sheets that they miss out on macro events that make headlines. A European crisis might not affect a fund's holdings—but fund investors have a right to expect their portfolio manager to be able to explain why.

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